10 Investing Terms You Should Know if You Work in Tech
Equity compensation is a cornerstone of the tech industry, acting as both an incentive and reward for talented professionals. But for newcomers and seasoned pros alike, the terminology can be baffling. Here are 10 terms you should know if you work in tech and want to better understand your stock-based compensation package.
1. Equity
At its core, equity represents ownership in a company. When a company offers you equity, it offers a piece of its ownership, usually in stock or options.
2. Stock Options
These contracts grant the right, but not the obligation, to buy shares at a set price. They come in two main flavors:
ISOs (Incentive Stock Options): Tax-advantaged stock options for employees.
NSOs (Non-Qualified Stock Options): Stock options without specific tax advantages, which can be granted to employees, consultants, or board members.
3. RSUs (Restricted Stock Units):
A promise from the company to give you shares (or the cash equivalent) at future vesting dates. Unlike stock options, you don't have to buy RSUs; they're given to you.
4. Vesting
This refers to the process by which an employee gains access to their stock or stock options over time. A common schedule might be a 4-year vesting with a 1-year cliff. In this example, you'd get 25% of your options or shares after one year, and the rest distributed over the remaining three years, typically in monthly or quarterly increments.
5. Exercise
This is the act of buying stock by using your stock options. You "exercise" your options by purchasing shares at the previously agreed-upon price.
6. Strike Price (or Exercise Price)
The fixed price at which you can buy shares using your stock options.
7. Fair Market Value (FMV)
The current value of a share in the open market. When exercising options, the difference between the FMV and the strike price can have tax implications.
8. Liquidity Event
An event that allows shareholders to sell their shares for cash. Common events include an IPO (Initial Public Offering), when a company goes public, or an acquisition by another company.
9. Dilution
As companies issue more stock (for new employees, investments, etc.), your percentage ownership in the company might decrease. This is called dilution. However, the hope is that the company's overall value increases, making your smaller piece worth more.
10. 83(b) Election
A tax strategy move where you opt to pay taxes on the total fair market value of your equity upfront, rather than as it vests. This can be beneficial if you believe the company's value will rise significantly.
Navigating the landscape of equity compensation can be challenging, but understanding these terms is the first step to unlocking its benefits. As always, when dealing with equity and potential tax implications, it's wise to consult with a financial advisor or tax professional to make informed decisions.
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